Rules of Origin and Gains from Trade

Abstract

This paper identifies the most restrictive limit that rules of origin can enforce and still continue to guarantee gains from trade for free trade area formation in general settings. Many commonly used rules of origin exceed this condition in practice. Second, free trade areas generally involve unharmonized tariffs requiring rules of origin that make standard analyses difficult or inapplicable. We incorporate the identified welfare-supporting ruels of origin into standard existence of equilibrium proofs and prove the existence of a free trade area equilibrium involving only WITHIN-FTA transfers that is at least as satisfactory for every consumer worldwide as an arbitrary original world trade allocation. The analysis explains why hub-and-spoke extensions of free trade areas cannot guarantee gains from trade for all participants in general.

Keywords: rules of origin, free trade areas, Walrasian equilibrium, welfare analysis

JEL Classification: D60, F13, F15